$A to weaken if Fed puts stimulus to bed

The Australian dollar could fall closer towards the Reserve Bank’s mid-US80¢ comfort range this week on growing speculation that the US Federal Reserve will finally start to unwind its mammoth stimulus policy.

Financial markets are pricing in the likelihood of the US Federal Reserve reducing its $US85 billion in monthly bond purchases this week. The Australian dollar broke below US90¢ on Friday – the same level it was at prior to the Fed’s last official meeting on the matter in early September.

“The market is priced for something to happen," said UBS Global Asset Management head of investment strategy Tracey McNaughton. “The Australian dollar is where it was in September when the market really thought that the Fed would taper but it didn’t."

The yield on US 10-year Treasury bonds are 40 basis points higher from their lows, which is very similar to where they were prior to the Federal Open Market Committee meeting in September.

At that time, the Fed said it decided to hold off on tapering on concerns about the US government’s budget negotiation and debt ceiling standoff, but now those issues have been resolved.

“If anything, since September the economic data has improved," said Ms McNaughton.

“So the Fed is running out of reasons why it should not taper."

All eyes will be on the FOMC meeting in Washington DC on Wednesday, where investment experts say there is a 50 per cent chance that
Ben Bernanke
will use his final meeting as Fed chair, before handing over to
Janet Yellen
in February, to change the central bank’s stimulus.

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“I think the Fed would like to taper as soon as possible," said BT Investment Management head of income and fixed interest Vimal Gor. “The decision when to taper will be driven by politics, be it the end of the Bernanke legacy or start of Janet Yellen as Fed chairman. It will not be driven by economic data."

The Australia dollar fell to US89¢ on Friday, after The Australian Financial Review reported comments by RBA governor
Glenn Stevens
, who said a valuation closer to US85¢ was desirable and a lower currency was his ­preference over further interest rate reductions.

“I thought [US]85¢ would be closer to the mark than [US]95¢ . . . but really, I don’t think we can be that precise," he said in an interview published on Friday.

The local currency has fallen 16¢ since starting the year around US$1.05, over which time the RBA has cut the official cash rate twice to an historic low of 2.5 per cent in an effort to stimulate growth in the domestic economy.

The central bank’s easing bias is likely to be reiterated on Tuesday when the minutes from the RBA’s early December policy meeting are released.

The federal government’s mid-year budget review is also due on Tuesday and is widely expected to show the budget deficit has blown out to $50 billion, which could undermine business confidence.

Investors will also be focusing on parliamentary testimony by Governor Stevens on Wednesday, when he is likely to use the opportunity to talk down the Australian dollar once again.

It’s hoped that if the currency weakens further that this will drive growth in non-mining sectors, such as retail and tourism.

“The RBA would really like to see a weaker Australian dollar to help stimulate the economy," said Mr Gor. “A weaker dollar would help lift business confidence and impact growth much more than lower interest rates."

But not everyone thinks that the Australian dollar is headed lower in the coming weeks.

Westpac chief currency strategist Robert Rennie thinks the currency should move back above US90¢ on the assumption that the Fed won’t taper its stimulus program until 2015.

“I think the market has got ahead of itself on thinking the Fed will begin tapering in December," said Mr Rennie. “Not a lot has changed since September when the Fed backed away from ­tapering.

“So I think it is way too early to speculate that December is a done deal. I don’t see the urgency in removing tapering in December, they can afford to wait till March," he said.

A mix of better than expected US economic data, in terms of retail sales, manufacturing and jobs figures in November has got other investment experts also picking a March taper date.

“On the taper, it is a close-run thing but we think the Fed will still err on the side of caution and wait a bit longer, said Commonwealth Bank of Australia chief economist Michael Blythe.